Arguments from both sides and the basis for why taxing the trusts in MN was deemed unconstitutional
In Fielding v. Commissioner of Revenue, the court concluded that the contacts on which the Commissioner relied are either irrelevant or too attenuated to establish that Minnesota’s tax on the trusts’ income from all sources complies with due process requirements.
The 3 Primary Reasons the Minnesota Supreme Court Sided With Fielding
The grantor’s connections to Minnesota are not relevant to the relationship between the trusts’ income that Minnesota seeks to tax and the protection and benefits Minnesota provided to the trusts’ activities that generated that income.
The relevant connections are Minnesota’s connection to the trustee, not the connection to the grantor who established the trust years earlier. A trust is its own legal entity, with a legal existence that is separate from the grantor or the beneficiary.
Nor did the court find the grantor’s decision to use a Minnesota law firm to draft the trust documents to be relevant.
Thus, the grantor Reid MacDonald is not the taxpayer, the trusts are.
The trusts did not own any physical property in Minnesota that may serve as a basis for taxation as residents. The trusts held interests in intangible property, FFI stock.
Although FFI was incorporated in Minnesota and held physical property within the state, the intangible property that generated the trusts’ income was stock in FFI and funds held in investment accounts.
These intangible assets were held outside of Minnesota, and thus, do not serve as a relevant or legally significant connection with the state of Minnesota.
The court did not find the contacts with Minnesota that pre-date 2014 by the grantor, the trusts, or the beneficiaries to be relevant.
The taxpayer—holder of the legal title to the stock in FFI and the other income-producing intangible assets—is the trustee, who is not a Minnesota resident. Intangible assets are appropriately taxed as being resident in the jurisdiction where the owner of legal title—the trustee—is a resident.
The court was left to consider the extremely tenuous contacts between the trusts (or their trustees) and Minnesota during the tax year 2014. The Trustees had almost no contact with Minnesota during the applicable tax year. All trust administration activities by the Trustees occurred in states other than Minnesota.
The Argument: The Commissioner vs. Fielding
The Commissioner of Minnesota
The Commissioner contended taxing the trusts’ worldwide income based on several contacts between Minnesota and the trusts was, in fact, constitutional.
- Specifically, the grantor, Reid MacDonald, was a Minnesota resident when the trusts were created in 2009 and MacDonald was domiciled in Minnesota when the trusts became irrevocable in 2011, and still domiciled in Minnesota in 2014.
- The trusts were created in Minnesota, with the assistance of a Minnesota law firm, and until 2014, the Minnesota law firm retained the trust documents.
- The trusts held stock in FFI, a Minnesota “S corporation.”
- The trust documents indicate that questions of law arising under the trust documents are determined by Minnesota law.
- One beneficiary, Vandever MacDonald, has been a Minnesota resident at least through the tax year at issue.
When Fielding filed tax returns in 2014, they were filed under protest landing in the Minnesota Tax Court. Fielding wins in the tax court. Minnesota appealed to the supreme court.
- No trustee has been a Minnesota resident.
- The trusts have not been administered in Minnesota.
- The records of the trusts’ assets and income have been maintained outside of Minnesota.
- Some of the Trusts’ income is derived from investments with no direct connection to Minnesota.
- Three of the four trust beneficiaries reside outside of Minnesota.
Alliance Trust Company of Nevada is hosting a panel discussion on the Fielding case and its impacts on August 27, 2018, in Minneapolis, MN. Click here to learn more.
The basis for the Minnesota Supreme Court ruling in favor of Fielding
- A state can only tax entities in a tax year when they receive a benefit from a state and must have reasonable connections to the taxing state.
- A single factor from the Minnesota Stat. § 290.01, subd. 7b(a)(2) (2016)–the grantor’s domicile at the time the four trusts became irrevocable–was deemed unconstitutional since it relied on that factor alone in defining the trusts as Minnesota Resident Trusts.
- The court affirmed the decision of the Minnesota Tax Court because in the Fielding case the trust(s) lacked sufficient relevant contacts with Minnesota during the applicable tax year for the trusts to be permissibly taxed as Minnesota residents.
- The court analogized the case to a hypothetical statute authorizing that any person born in Minnesota to resident parents is deemed a resident and taxable as such, no matter where they reside or earn their income. The court believed this would be undoubtedly outside of the State’s power to impose taxes.
The State lacked sufficient contacts with the trusts to support taxation of the trusts’ entire income as residents consistent with due process.
Attributing all income, regardless of source, to Minnesota for tax purposes would not bear a rational relationship with the limited benefits received by the Trusts from Minnesota during the tax year at issue.
Courts have said that a tax will satisfy due process if (1) there is a “minimum connection” between the state and the person, property, or transaction subject to the tax, and (2) the income subject to the tax is rationally related to the benefits conferred on the taxpayer by the State.
The court conclude that in the context of a due process challenge to the State’s taxation of a taxpayer as a resident, the court will examine all relevant contacts between the taxpayer and the State, including the relationship between the income attributed to the state and the benefits the taxpayer received from its connections with the state. Taxation needs to be fairly apportioned to activities within the state.
The court considered whether the trusts’ contacts with Minnesota were sufficient, under the Due Process Clause, to permit them to be taxed as Minnesota residents.
A state’s tax satisfies due process if there is:
- Some “minimum connection” between the state and the entity subject to the tax
- A “rational relationship” between the income the state seeks to tax and the protections and benefits conferred by the state. “there must be a connection to the activity itself, rather than a connection only to the actor the state seeks to tax”